output. If the firm plans to double its level of output, it should also double the
use of each input, leaving the proportions unchanged. These input proportions
(in combination with prevailing input prices) determine the firm’s average cost
per unit. In Figure 6.3, LAC C/Q $4. The long-run total cost function is
C 4Q. Thus, long-run marginal cost (LMC) is also $4 per unit. As the figure
shows, long-run marginal and average costs are constant and identical.
Figure 6.3 also shows the short-run average cost curves for three possible
plants of varying sizes. The firm’s plant (and equipment therein) represents the
total capital input. The left curve is for a 9,000-square-foot plant, the middle
curve for an 18,000-square-foot plant, and the right curve for a 27,000-square-
foot plant. Notice that the smallest plant is optimal for producing 72,000 units
of output. With such a plant in place (and using the right amount of labor), the
firm can produce this output level at a minimum average cost of $4. If the firm
planned to produce twice the level of output (144,000 units), it would use a
plant twice the size (an 18,000-square-foot facility) and twice the labor. Finally,
the largest plant is optimal for producing 216,000 units.
Once its plant is in place, however, the firm has considerably less flexibil-
ity. In the short run, its plant cannot be varied. Thus, if a 9,000-square-foot
plant is in place, production of an output, such as 108,000 units (see Figure 6.3),
means an increase in the average cost of production above $4. Why? To pro-
duce this output requires expanding the use of labor (since the plant is fixed).
Because of diminishing returns, the extra output comes at an increasing mar-
ginal cost, and this drives up average cost as well.
Obviously, the firm may have many choices of plant size, not just three.
Before its plant is in place, the firm has complete flexibility to produce any
level of output at a $4 unit cost. It simply builds a plant of the proper scale and
applies the right proportion of labor. In this long-run planning horizon, it
enjoys complete flexibility as to the scale of production. However, once the
plant is built and in place, any change in planned output must be achieved by
a change in labor (the sole variable input). The result is a movement either
right or left up the U of the relevant SAC curve. In either case, there is an
increase in average cost.244 Chapter 6 Cost AnalysisComparative
Advantage and
International
TradeIn a host of industries, such as electronics, automobiles, computers, aircraft,
and agricultural products of all kinds, competition is worldwide. The major
industrial countries of the world compete with one another for shares of global
markets. For numerous goods, a U.S. consumer has a choice of purchasing a
domestically produced item or a comparable imported good made in a far-
flung corner of the world—for instance, Europe, East Asia, or South America.
Thus, a knowledge of international trade is essential for successful managers in
increasingly global industries.
International trade is based on mutually beneficial specialization among
countries. Why does one country concentrate on production and exports inc06CostAnalysis.qxd 9/29/11 1:46 PM Page 244